Title: Introducing MEV Taxes: A Creative Approach to Redistributing MEV Value
Researchers Dan Robinson and Dave White from Paradigm have introduced a new concept called “MEV taxes.” The MEV tax mechanism allows applications to recover a portion of MEV from transactions, with the aim of redistributing the value of MEV to prevent it from being entirely captured by transaction searchers. This mechanism can be effectively implemented on OP Mainnet, Base, Blast, and other OP Stack L2 platforms.
Introduction to MEV Taxes
MEV taxes are a mechanism that allows smart contracts to automatically extract fees by analyzing the priority fees in transactions. In this framework, smart contracts charge a certain percentage of MEV tax based on the priority fees of transactions. Priority fees are the fees users pay to accelerate the confirmation of their transactions on the network. After EIP-1559, Ethereum’s transaction fees are divided into base fees and priority fees. The base fee is automatically set by the network and dynamically adjusted based on network congestion, while the priority fee is the additional fee paid by users to block proposers to incentivize them to prioritize processing their transactions.
Smart contracts collect proportionally additional fees based on the priority fee of transactions, known as MEV tax. For example, under MEV tax, a user pays 1u of priority fee to the block proposer to incentivize them to prioritize processing the transaction. In order for the searcher to capture all the MEV from this transaction (e.g., profit 100u), they must pay 99u to the smart contract based on the 1:99 fee ratio set by the smart contract interacting with the transaction. This 99u will be returned to the application (used to provide rewards to users, etc.). Without MEV tax, the user would pay 1u of priority fee, and the proposer would receive 1u for processing the transaction, but all the MEV generated by the transaction (100u) would go to the searcher.
Effectiveness Based on Competitive Priority Ordering Rules
The effectiveness of MEV taxes is based on the rules of “competitive priority ordering”:
Sorting by priority fee: Block proposers should sort transactions based on the priority fees, with higher priority fee transactions being processed first.
No censorship: Block proposers cannot censor or exclude any transactions, even those with lower priority fees.
No peeking and delay: Block proposers cannot peek at transaction contents in advance, nor can they arbitrarily delay the processing of certain transactions.
Based on these rules, MEV taxes are only effective on OP Stack L2 platforms where block proposers (sorters) adhere to competitive priority ordering rules. If sorters violate these principles, they can evade MEV taxes by manipulating the order of transactions to capture the value for themselves.
For Ethereum L1, block construction is carried out through competitive block-building auction systems like MEV-Boost, where multiple block builders compete to maximize their income by including high-fee transactions. Since MEV taxes reduce the income of builders, in highly competitive block-building environments, builders are likely to prioritize transactions not subject to MEV taxes, making this mechanism ineffective on Ethereum.
Issues Addressed by MEV Taxes
MEV taxes can be adopted by any smart contract without the need for specific external infrastructure, allowing smart contract developers to customize their fee models according to their application requirements. This flexibility ensures that different blockchain protocols and applications can optimize their strategies while remaining compatible with other systems. For example:
Optimizing DEX transactions: When introducing MEV taxes in DEX, transaction execution prices are influenced not only by market supply and demand but also by MEV taxes. Searchers need to pay higher MEV taxes to complete transactions faster and get better prices. This portion of the fee can be used to increase the transaction’s priority in the block or as a reward mechanism, feedback to users or liquidity providers, potentially changing the execution price of the transaction and indirectly reducing transaction price slippage.
Reducing losses and rebalancing issues for liquidity providers in AMMs: AMMs can prioritize processing transactions with higher MEV taxes, allowing them to directly recover profits from arbitrageurs and return them to AMMs or liquidity providers, ensuring more stable income for liquidity providers.
Capturing “backrun” MEV generated by transactions: By integrating MEV taxes into smart contract wallets, users can automatically collect MEV taxes when transacting. This way, when other market participants try to exploit the MEV generated by user transactions, they must pay MEV taxes, which can be returned to the original transaction’s user. This mechanism effectively allows users to capture the MEV generated by their transactions, protecting their interests.
Limitations of MEV Taxes
In addition to the high dependency of MEV taxes on sorters strictly adhering to competitive priority ordering rules, there are other limitations. For example, when blocks are completely filled, block proposers may have to prioritize higher-priority transactions instead of simply including lower-priority ones in the later part of the block. The success of MEV taxes requires competition in the market, meaning that transaction opportunities need to be widely known. For some intent-based applications, this may require publicly disclosing user intent, potentially leading to value leakage in competition.
While the MEV tax mechanism faces some challenges and limitations, this innovative approach is a way to fairly redistribute MEV, returning the MEV profits that would have originally gone to searchers back to applications. MEV taxes and MEV Share have similar goals, both seeking ways to return MEV to promote fair distribution within the MEV ecosystem.
